PBOC Pulls the Trigger on Yuan Band Widening

China’s central bank pulled the trigger on something the market already knew it was aiming at — widening the trading band for the nation’s currency. The People’s Bank of China said it would allow the yuan to move 2% above or below a rate it sets every day for the currency against the U.S. dollar, up from 1% now, in a move that will mean the yuan will behave a little more like major currencies.

The policy move, which takes effect Monday, still lets the PBOC keep its thumb on the foreign exchange scale, knowing the currency won’t move more than 2% away from where it wants it on any given day.

The central bank was widely seen as preparing the market for just such a move when it let the currency slip repeatedly last month. Still, the central bank managed to surprise more than a few people with the timing of its announcement — just before dinner hour on Saturday night. One analyst referred to this as “PBOC style” with the central bank showing that it still could shake things up just a little when it wanted.

The PBOC, which last expanded the band to 1% from 0.5% in April of 2012, said that this was part of its effort to make the exchange rate more market-based, and that it would continue to push ahead with this effort. It also said this did not mean either a big depreciation – or appreciation for the currency — in the future and it added that Chinese companies were already better prepared to deal with somewhat greater yuan fluctuations.

It also said it would withdraw from routine intervention in the foreign exchange market.

Analysts generally applauded the move — which had been already been touched on in Premier Li Keqiang‘s work report delivered at the opening of the annual session of parliament this month.

Following are some of comments from analysts (edited for style and length):

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“This was a good time to widen the trading band. It came at a time when there was a rather large division in the views on the direction of the yuan and came against a background of slowing capital inflows,” wrote Bank of Communications economists in a note to clients. “This can effectively avoid a big appreciation or depreciation of the yuan’s exchange rate immediately following the move.”

They added that central bank will probably push ahead with the introduction of new foreign exchange-related products, relax some restrictions on fund movements under the capital account and it might raise its ceiling on domestic bank deposit interest rates this year.

(Editor’s explanatory note: Domestic bank deposit rates are currently capped at 1.1 times a benchmark rate set by the central bank. Liberalized interest rates and relaxed capital account restrictions are seen as key parts of a package of inter-related financial reforms).

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“Today’s band widening strengthens the PBOC’s signal that the one-way bet on the yuan is over and we should expect more yuan/dollar volatility going forward,” Lu Ting, economist at Bank of America Merrill Lynch, wrote in a note to clients.

“We believe the PBOC won’ stop here, but further band widening is of little meaning. A much more important and meaningful reform is to change the rule on setting the daily fixing of yuan/dollar. As an intermediate step, the PBOC could peg the yuan to a basket of currencies weighted by the importance of (China’s) trading partners.”

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“If the PBOC really withdraws from intervening in the market in the near term there would be more volatility,” said Ma Xiaoping, economist at HSBC. “They will probably withdraw gradually.”

“The PBOC has been signaling that it was moving in this direction. In the future there will be a more flexible exchange rate based on market supply and demand.”

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“The central bank is trying to spur businesses and financial institutions to prepared for a more flexible exchange rate,” said Louis Kuijs of RBS.

“They want to let this volatility happen so people will up their game. They want volatility but it’s going to be a bit contrived, generated by policy not by the market,” he said.

“It might not lead to big changes on a day-to-day level, but it signals they are serious about moving toward more flexibility.”

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“The move was as we anticipated though the margin of the band widening was less than we had expected,” said Lu Zhengwei of Industrial Bank in a comment on his Sina Weibo account. “We had expected 2.5%-3.0% and this shows that the authorities are being cautious.”

The economist also said: “This also shows the yuan’s recent depreciation is over and we will now see two-way movement in the exchange rate.”

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